Unveiling the legal Compliance framework of TON

TON (The Open Network) is one of the most followed Blockchain projects in the current Web3 world. Developed by the original Telegram team, TON is committed to building a highly Decentralized and scalable Blockchain platform. Its core technologies include multi-chain architecture and dynamic Sharding technology, aiming to solve the common scalability and speed issues in the Blockchain field. TON’s ecosystem supports multiple application areas such as payment systems, Decentralized storage, Social Web, providing extensive support for developers.

The Past and Present of TON

Understanding the relationship with Telegram is crucial to understanding TON. Telegram is a free instant messaging software founded by Pavel and Nikolai Durov in 2013. With its high level of security and user experience, Telegram has rapidly grown into one of the world’s leading communication platforms, with nearly 9 billion monthly active users to date, and has become an important tool for the Web3 community.

In 2017, facing the huge user base of Telegram, the Durov brothers began to explore the blockchain solution, but found that there was no Layer1 blockchain on the market that could meet their needs. Therefore, they decided to design their own Layer1 chain, namely Telegram Open Network (TON). Through a round of token (Grams) sales in 2018, Telegram raised $1.7 billion, setting a record for fundraising in the encryption industry.

• Image Source: TON Official Website

However, just as the TON team released detailed blockchain design architecture and launched two test networks, in October 2019, the United States Securities and Exchange Commission (SEC) accused Telegram of conducting an unregistered securities issuance. This legal challenge greatly hindered the project’s progress. After prolonged communication and legal battles with the SEC, Telegram announced in May 2020 that it would cease the development of TON and agreed to pay a $18.5 million settlement, while promising to refund the funds to investors.

Telegram’s withdrawal did not mark the end of the TON project. Between 2020 and 2021, a team of passionate Open Source developers called NewTON took up the mantle, inheriting and delving into the technical architecture and codebase of TON, remaining faithful to the original design concept, and ultimately relaunching the project. In May 2021, NewTON was formally renamed the TON Foundation, and TON was also renamed from its original name Telegram Open Network to The Open Network, continuing to move towards Decentralization and scalability.

TON’s Compliance Challenges

During the period from 2019 to 2020, the original TON project’s conflict with the Securities and Exchange Commission (SEC) of the United States was not only limited to the issue of unregistered securities, but TON was also accused by the SEC of ‘insufficient investor protection’ issues. According to the SEC’s accusation, the Mann Law Firm identified several Compliance issues:

Unregistered Securities Issuance

Essentially, the dispute between TON and the SEC touches on a highly challenging issue in the digital asset space: how to define the nature of digital tokens and whether they should be considered as securities. According to the “howey test” (Howey Test) in the United States, an investment constitutes a security if it meets the four conditions of investment of money, expectation of profits, investment in a common enterprise, and profits primarily from the efforts of others. Therefore, in the case of TON, the SEC considers that Grams meet these conditions, and thus should be deemed as securities and subject to corresponding regulation.

Investor Protection and Transparency

In addition to the primary issue of unregistered issuance, the SEC also alleges that TON’s investor protections are inadequate. The SEC believes that Telegram failed to adequately disclose risk information related to Grams tokens, particularly in terms of the token’s economic model, management structure, and market potential. The lack of this information could lead investors to make investment decisions on an incomplete information basis and face higher risks.

Cross-border Legal Challenges

TON, as an international project, its fundraising activities touch multiple legal jurisdictions worldwide. This not only complicates compliance, but also means facing potential conflicts and challenges of multiple national laws, further increasing legal risks.

These challenges are hard lessons for the TON project, but they also provide important insights and are applied to its subsequent Compliance strategy. Next, Manchu lawyers will focus on analyzing the brand new TON architecture and its Compliance strategy, providing inspiration for Web3 entrepreneurs.

TON’s Compliance Architecture

After experiencing legal conflicts with the SEC, the TON project refocused on building a sound Compliance framework to address possible legal and regulatory challenges in the future. After a deep dive into the TON official website, lawyer Mancun discovered the way TON maintains stable and active operations in multiple jurisdictions through Compliance.

Non-profit organization: TON Foundation

The legal dispute with the U.S. Securities and Exchange Commission (SEC) that lasted for six months starting from October 2019 has had a profound impact on TON. Therefore, in the process of re-establishing a compliance framework, TON has chosen to continue its development in the form of a non-profit organization, namely, The Open Network Foundation. The foundation has selected Zug, Switzerland, known as the Crypto Valley for its cryptocurrency-friendly regulations, as its new legal domicile, which is renowned for its high compliance costs.

• Image Source: TON Foundation Official Website

From the official disclosures, the TON Foundation claims to be 'a non-profit organization entirely funded by community donations and is committed to safeguarding the interests of the community by supporting initiatives that help achieve its mission. The foundation supports the TON project without controlling the TON technology, and is one of the many network contributors to the Decentralization TON community. TON runs on the Open Source codebase, allowing anyone to contribute, and there is no single controlling entity.

The terms ‘non-profit, non-control, Decentralization, mission, support’ describe both the role of the TON Foundation and imply the legal effect that the foundation’s architecture will have - isolating the risks that may arise from Token issuance.

In fact, according to the official disclosure, as the supervision and education institution of the TON blockchain and its related ecosystem, the TON Foundation has undertaken a lot of specific functions. Including:

• Community Governance. By publishing detailed roadmaps and regular progress reports, the foundation ensures not only the transparency of the project, but also grasps the development direction of TON. These reports elaborate on the tokenomics, issuance strategy, partner allocation, community incentives, asset operation and ecosystem usage of TONcoin.
• User Education. The Foundation provides educational resources to introduce the basics of blockchain and TON’s unique technology and ecosystem to enhance user understanding and participation.
• Developer support. The foundation coordinates, supports, and funds projects valued by the community through the Grants Program, which not only attracts more developers to join, but also promotes the rise of the network and the activity of users.
• Brand Collaboration. For example, on July 22, 2024, the TON Foundation and MOCA Foundation announced the establishment of a $20 million reserve for MOCA Coin and TONcoin. Through joint incentive measures such as open alliances, hackathons, and accelerator programs, developers and users are encouraged to adopt the TON ecosystem.
• Community Operations. Despite being a non-profit organization, the foundation seems to have taken on some commercial operational functions. For example, interviews and press releases are often directly issued in the name of the foundation within the community. In a publication dated July 23, 2024, it explicitly mentioned, “This is where the TON Foundation explores meme coins in the TON Eco,” indicating that the TON Foundation’s risk isolation is not thorough.

The TON Foundation has chosen Switzerland as its registered location in its architecture, striving for a high level of Compliance to mitigate legal risks. Its Decentralization and non-control statements are aimed at preventing regulatory risks arising from Token issuance. However, the specific functions undertaken by the foundation in its actual operations and its relationship with commercial activities may need further clarification of its role to ensure full compliance with non-profit organization regulations and to avoid potential legal and tax issues. This Compliance framework requires ongoing legal review and transparency to ensure compliance with regulatory requirements in various countries and to maintain public trust.

Operating Entity: TON Community

Although the TON Foundation has taken on some community operations functions, more community operations are still the responsibility of the TON Society. According to information disclosed on the official website, TON Society has established active local communities in 9 centers in Europe, Southeast Asia, and the Middle East, holding as many as 16 events each month, including various large conferences and activities, typically involving a large number of participants and open discussions. Therefore, one Compliance challenge facing TON Society is the potential inability to fully control all remarks made at these events, especially in terms of public safety and speech management, which could lead to legal liability. In certain jurisdictions, this situation may be particularly sensitive if the activities involve the promotion of securities, financial products, or other regulated activities, easily triggering regulatory authorities’ attention.

• Image Source: TON Official Website

Lawyer Mankun found from the traces on the TON official website that TON Society should be a qualified legal entity, but it has not been established yet. At the same time, TON seems to be planning to set up an offshore structure of a BVI company for the operating entity, aiming to deal with potential legal liabilities brought by large-scale community activities. After all, operators are difficult to avoid holding large meetings, difficult to control participants from making “passionate” remarks, and are relatively easy to attract regulatory follow in specific jurisdictions.

The strategy of establishing an offshore company not only helps to reduce the risks arising from legal liabilities, but also enhances the legal protection of TON Society.

Developer and Investment Subject

From the contact information left in the privacy policy document on the TON official website, office@falabs.io, it is apparent that First Stage Labs (also known as Top Labs or The Open Platform) is an important part of TON. According to public information, this organization is registered in the United Arab Emirates and is a venture capital studio that focuses on seed round investments in the TON ecosystem. It has multiple public investment records, indicating its core role in the TON ecosystem.

• Image Source: crunchbase Official Website

According to the information disclosed by Top Labs, in addition to investment, Top Labs also has the co-building capability, which to some extent demonstrates its strength as a development company. In particular, Top Labs operates several key functions of the TON official website, such as managing the Wallet function of TON and operating a DEX platform called STON.fi. In addition, Alena Shmalko, the head of the TON Foundation’s ecosystem, publicly acknowledged that the Wallet function is operated by Top Labs, further confirming the crucial role of Top Labs in development and technical services.

Another point worth noting is the TONStat function, which updates the statistical data of TON Block on-chain on a daily basis, such as total transaction volume, performance, total fees, etc. The contact email is TONstat@fslabs.io, which is also another direct participation point of Top Labs.

Although Alena Shmalko, the head of the TON Foundation ecosystem, mentioned in a conversation, “This is not our team, it is a completely different company called TOP (The Open Platform). They are responsible for operating the Wallet, running one of the DEX on TON, STON.fi, and many other good TON projects, all of which are invested in and built by TOP.” Given the independent structure of the foundation, without shareholders, he is not wrong in terms of equity legal relations. But those in the know understand.

First Stage Labs plays an important role in providing technical and investment support within the TON ecosystem. Its independence and specific functional division are crucial for the overall compliance and legal risk management of TON. Although the TON Foundation and First Stage Labs are legally independent, close cooperation and overlapping roles in actual operation may raise complex legal and compliance issues. TON needs to ensure transparency, clarify responsibilities of all parties, and comply with relevant legal and regulatory requirements to maintain the compliance and stability of the entire TON ecosystem.

Inspiration for Web3 startups

The Compliance architecture of TON provides a successful example of how a Web3 project can ensure global operational legality and sustainable development through multi-level legal and compliance arrangements. Here are a few points that other Web3 startups can learn from TON’s experience:

In-depth Understanding and Application of International Law

Web3 companies should thoroughly research the legal environment of their target market before launching, especially the laws related to Cryptocurrency and blockchain technology. For example, TON’s choice of Switzerland as its place of registration takes advantage of Switzerland’s relatively clear and friendly Cryptocurrency laws. In addition, companies should also consider potential conflicts in the laws of other countries and regions, especially in cross-border transactions and operations, to ensure the legality and feasibility of their business model on a global scale.

Risk Isolation Strategy

By establishing independent legal entities or using a decentralized corporate structure (such as BVI offshore companies), it is possible to effectively isolate the legal risks that may arise from the actions of certain departments of the company. The multi-layered corporate structure of TON can serve as an example of isolating risks in technology development and fund operation. This structure helps protect core assets when facing legal litigation or regulatory scrutiny.

Establish a sound Compliance review mechanism

Web3 should establish a systematic Compliance audit mechanism, which not only monitors the internal Compliance of operations, but also reviews the Compliance status of external partners and service providers. For example, TON manages certain key functions through Top Labs, but at the same time, it is necessary to ensure that the operations of these service providers fully comply with legal requirements.

Transparency and Communication with the Community

Increasing transparency in project progress, financial status, and management decisions is key to building trust. Transparent operations and regular community updates, such as those of the TON Foundation, help enhance the confidence of users and investors and reduce regulatory concerns. Additionally, effective community communication can increase user engagement and provide more market feedback and development momentum for the project.

Strategic Planning for Dealing with Complex Legal Challenges

Web3 projects should anticipate and prepare to address legal challenges from different jurisdictions. This includes working with professional legal advisors, regularly assessing the project’s compliance, and preparing to address potential legal disputes. TON’s experience demonstrates the importance of timely communication with regulatory authorities and reaching settlements.

By implementing these strategies, Web3 companies can not only enhance their own legal risk resistance, but also steadily expand in the global market, while ensuring compliance with increasingly strict legal and regulatory requirements in various countries. These measures will help entrepreneurs build a sustainable and legitimate Compliance global business.

Reference materials

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